Chapter 6 Study Notes

Question 1

registration statement,

Answer 1

The Securities Act of 1933 attempts to prevent fraud in the sale of new issues by requiring that investors be provided with enough relevant information about the offering to make an informed decision. This information is provided through a registration statement, which is a public document that’s filed with the SEC and designed to provide full disclosure of all material information about the issuer and the offering.

Question 2

A summary of the registration statement

Answer 2

—the prospectus—must be provided to all purchasers of the new issue.

Question 3

SEC Registration Exemptions

Answer 3

In certain situations, new issues of securities can bypass the SEC registration process by way of an exemption. An exemption can be of great financial benefit to an issuer, since it won’t incur the time and expense of registration.

Question 4

SEC disclosure on a prospectus

Answer 4

The front cover of every prospectus must display a statement that describes the limitations of the SEC’s review.

Question 5

SEC Registration

Exempt Securities

Answer 5

The following securities are exempt from the registration and prospectus requirements of the Act:
Municipal securities
U.S. government securities, U.S. government agency securities, and U.S. government sponsored enterprises
Securities that are issued by non-profit organizations
Short-term corporate debt instruments (e.g., commercial paper) that have maximum maturities of 270 days
Securities issued by domestic banks and trust companies (but not bank holding companies)

Question 6

Antifraud Rule

Answer 6

In addition to specific registration requirements, the Securities Act of 1933 prohibits fraud in connection with the sale of any new issue. This antifraud rule also applies to government and municipal securities as well as other types of issues that are otherwise exempt from the Act.

Question 7

SEC Rule 15c2-12: Municipal Securities Disclosure

Underwriters

Answer 7

SEC Rule 15c2-12 assists an underwriter in meeting its obligation to have a reasonable basis when recommending a municipal security. According to this rule, an underwriter:
 Must obtain and review an official statement prior to bidding for or purchasing the securities. The official statement must be considered to be in final form by the issuer at that time. Since the following information may not yet be known, it can be omitted:
– Offering price
– Interest rate
– Selling compensation
– Aggregate principal amount and principal amount per maturity
– Delivery dates
– Rating
– Identity of the underwriter(s)
 For negotiated offerings, must send customers the most recent copy of the preliminary official statement, if any, within one business day of request
 Must contract with the issuer to receive, within seven business days after the agreement to purchase, offer, or sell the securities, sufficient quantities of the final official statement

Question 8

Exemptions SEC Rule 15c2-12

Answer 8

pertains to most primary offerings of municipal securities, with the following exceptions:
 Primary offerings with an aggregate principal amount of less than $1,000,000
 Bonds that are sold to investors in units of no less than $100,000 and sold to no more than 35 sophisticated investors (private placement)
 Any offerings that are sold by an issuer directly to an investor without using an underwriter (a direct loan)
 Bonds that are sold in $100,000 minimum denominations and mature in nine months or less

Question 9

Continuing Disclosure Requirements

Answer 9

EC Rule 15c2-12 includes provisions that an issuer or another obligated person may enter into a contract to provide continuing disclosure information to the MSRB’s EMMA website.
An obligated person is defined as any other entity that has legally agreed to support all or a part of the payment of the issue of securities. These disclosures typically contain financial or operating information and notices of material events.An underwriter is required to disclose to the MSRB whether the issuer or other obligated persons have agreed to provide continuing disclosure information as defined in SEC Rule 15c2-12. This contractual obligation by the issuer is generally found in the underwriting agreement. With respect to continuing disclosure requirements, the underwriter must disclose to the MSRB whether an issuer is providing continuing disclosures, the identity of any obligated person other than the issuer, and the timing regarding when the issuer or obligated persons have agreed to provide annual financial and operating data.

Question 10

Securities Acts Amendments of 1975.

Answer 10

1975 required dealers that participate in municipal securities transactions to be registered with the SEC and also created the Municipal Securities Rulemaking Board. The MSRB was designed to function as an independent, self-regulatory organization charged with primary rulemaking authority for the municipal securities industry. The MSRB was formally established on September 5, 1975 with the appointment by the SEC of its 15 initial members. Representation on the Board covers three areas—banks, securities firms, and public members.
Currently, the board is made up of 21 members who are knowledgeable of matters relating to municipal securities. Of the 21 members, 11 of the individuals must be independent of any municipal securities broker-dealer; however, the remaining 10 are associated with a municipal securities firm.

Question 11

MSRB Costs

Answer 11

The MSRB defrays the costs and expenses of its operation and administration by levying fees and charges on securities firms and dealer banks that engage in municipal securities business. Firms and dealer banks that effect municipal securities transactions must pay to the MSRB:
 An initial fee of $1,000
 An annual fee of $1,000
 A fee based on the volume of new issue underwritings in which the firm or dealer bank participates
 An assessment based on municipal securities transactions in the secondary market
 A technology fee

Question 12

The MSRB’s Rulemaking Authority

Answer 12

The MSRB has the authority to make rules that regulate the municipal securities activities of banks and securities firms only. In other words, the MSRB’s rules don’t apply to municipal securities issuers or investors. The Securities Acts Amendments of 1975 specifies the areas in which MSRB rulemaking authority is appropriate.

Question 13

MSRB rule making over dealer activity

Answer 13

 Standards of professional qualification and fair practice
 Recordkeeping
 The scope and frequency of periodic compliance examinations
 The form and content of quotations that relate to municipal securities
 Confirmation, clearance, and settlement of transactions

Question 14

MSRB Prohibition

Answer 14

The Municipal Securities Rulemaking Board is specifically prohibited from requiring issuers, directly or indirectly, to provide information to investors or the Board. However, the Board may require dealers to provide both investors and/or the Board with issuer documents that are generally available from sources other than the issuer (e.g., official statements which are supplied by dealers).

Question 15

MSRB

The Rulemaking Procedure

Answer 15

The MSRB’s rulemaking procedure involves several steps. First, the Board issues rule proposals in exposure draft form and provides for a public comment period of up to 60 calendar days. Then, the rule proposals are filed with the SEC as well as the federal bank regulatory agencies for their official review. The Act of 1975 requires the publication of the proposals in the Federal Register and another comment period prior to SEC approval. With the exception of rules relating solely to the administration of the Board and assessments, rules are generally subject to approval by the SEC prior to becoming effective.

Question 16

Enforcement of MSRB Rules

Answer 16

MSRB rules are enforced by the existing securities and bank regulators. For securities firms, the Board’s rules are enforced by FINRA and the SEC; however, the SEC “permits” FINRA to do most of the work. For dealer banks, MSRB rules are enforced by one of the following bank regulatory agencies:
 Comptroller of the Currency, in the case of a national bank or a subsidiary, department, or division of any such bank
 Federal Reserve Board, in the case of non-national banks that are members of the Federal Reserve System
 Federal Deposit Insurance Corporation, in the case of non-national banks that are not members of the Federal Reserve System

Question 17

MSRB rules regarding banks

Answer 17

An important note is that MSRB rules govern the municipal securities activities of a bank that are conducted on a dealer basis, in which the bank is buying or selling for its own account.
MSRB rules don’t cover municipal securities transactions of banks that are conducted on a fiduciary or agency basis, such as trust department transactions for clients. The municipal securities activities of securities firms (broker-dealers) are subject to MSRB rules for transactions that are executed on either a broker (agency) or dealer (principal) basis.

Question 18

Periodic Compliance Examinations

Answer 18

Each municipal securities broker-dealer must be examined at least once every four years to ensure that the firm and its associated persons are in compliance with all MSRB and SEC rules. This examination may be (and typically is) combined with other examinations that are conducted by the firm’s examining authority (i.e., the SEC, FINRA, Comptroller of the Currency, FRB, or FDIC) in order to avoid unnecessary regulatory duplication.

Question 19

associated person.

Answer 19

A person who is employed by a dealer-bank or firm and is directly engaged in the management, direction, supervision, or performance of any of the municipal securities dealer’s activities is referred to as an associated person.
For example, associated persons could be underwriters, traders, salespersons, analysts, or any person who communicates with the public, or any person in a supervisory capacity.

Question 20

Form U4 alternate for banks

Answer 20

the requirements for completing the questionnaire are satisfied when Form U4 is filed. For associated persons who will work for dealer banks, the requirements are satisfied when Form MSD-4 is filed.

Question 21

Municipal Securities Representative

Answer 21

must take and pass the MSRB’s Series 52 Examination during the first 180 calendar days after joining the firm or revert to a clerical or ministerial status
Series 52
 Underwriting, trading, or selling municipal securities
 Acting as a financial advisor or consultant for issuers in connection with the issuance of municipal securities
 Providing research or investment advice with respect to municipal securities
 Communicating, directly or indirectly, with public investors in municipal securities

Question 22

Municipal Securities Sales Limited Representative

Answer 22

If a person passes the Series 7 Examination after November 7, 2011 she’s qualified with the MSRB as a Municipal Securities Sales Limited Representative. A Limited Representative is only allowed to engage in sales to, and purchases from, customers involving municipal securities

Question 23

Municipal Securities Limited Representative – Investment Companies

Answer 23

A Municipal Securities Limited Representative is a person whose municipal securities activities are exclusively limited to sales to, and purchases from, customers involving municipal fund securities (e.g., 529 plans). To engage in these activities a person must successfully complete the Limited Representative – Investment Company and Variable Contracts Products Examination (Series 6).

Question 24

Municipal Securities Principal

Answer 24

An individual qualifies as a Municipal Securities Principal by taking and passing the MSRB Series 53 Examination
A Municipal Securities Principal is directly engaged in the management, direction, or supervision of one or more of the following activities:
 Underwriting, trading, or selling municipal securities
 Reviewing accounts, new account forms, and transactions
 Providing financial advisory or consultant services to issuers in connection with the issuance of municipal securities
 Processing, clearing, and in the case of municipal securities brokers and dealers other than bank dealers, safekeeping of municipal securities
 Providing research or investment advice with respect to municipal securities
 Communicating, directly or indirectly, with public investors in municipal securities, including handling customer complaints
 Maintaining, enforcing, and updating (at least annually) supervisory procedures
 Updating and reviewing written supervisory procedures based on Board rule changes
 Maintaining records on the activities listed above
 Training municipal securities representatives

Question 25

Principal Grace Period

Answer 25

The MSRB allows a candidate a 120-day grace period to pass the Municipal Securities Principal Examination (Series 53). In order to function as this type of principal prior to passing the examination, the person is required to be qualified as a General Securities Representative (Series 7), Municipal Securities Representative (Series 52), or General Securities Principal (Series 24). For example, a person who is only qualified as a Municipal Securities Sales Principal (Series 9/10) (described below) is not provided with the grace period and cannot function as a Municipal Securities Principal until he passes the Series 53 examination.

Question 26

Requirement to Have a Minimum Number of Principals

Answer 26

Municipal securities firms are required to have at least two Municipal Securities Principals if they engage in municipal securities transactions. However, if the firm conducts a general securities business and is a member of a registered securities association (e.g., an exchange or FINRA), it’s only required to have one Municipal Securities Principal. Additionally, if the firm has fewer than 11 associated persons who engage in municipal activities, the firm is required to have only one Municipal Securities Principal. If a firm limits its activities exclusively to municipal fund securities, it’s able to count any Municipal Fund Securities Limited Principal (Series 51) as part of the numerical requirement for Municipal Securities Principals.

Question 27

Municipal Securities Sales Principal

Answer 27

To qualify as a Municipal Securities Sales Principal, an individual must pass FINRA’s General Securities Sales Supervisor Exam (Series 9 and 10).Some of the activities for which a sales principal may be responsible includes:
 Approving transactions with customers
 Approving the opening of customer accounts
 Approving discretionary accounts and related transactions
 Reviewing all customer accounts regularly
 Supervising the handling of written customer complaints
 Reviewing correspondence with customers regarding the solicitation or execution of municipal securities transactions (but not advertising)

Question 28

Municipal Fund Securities Limited Principals

Answer 28

A Municipal Fund Securities Limited Principal generally acts in the same capacity as a Municipal Securities Principal; however, their activities are limited to municipal fund securities only.
An individual may qualify as a Municipal Fund Securities Limited Principal by successfully completing the Series 51 Examination. However, in order to conduct any principal-related activities she must also be registered as a General Securities Principal (Series 24) or Investment Company Products/Variable Contracts Limited Principal (Series 26).

Question 29

Municipal Advisor Representatives and Principals

Answer 29

A Municipal Advisor Representative is an individual who is associated with a municipal advisor and engages in advisory activities on the firm’s behalf. Any person who is employed by the advisor and whose duties are solely clerical or ministerial is NOT a Municipal Advisor Representative.
A Municipal Advisor Principal is an individual who is associated with a municipal advisor and manages the firm’s advisory activities and, for larger firms, supervises Municipal Advisor Representatives. Every municipal advisor must have at least one qualified principal. Both representatives and principals must pass the Series 50 Examination to be qualified. Principals will eventually be required to take an additional examination, but it’s still under development by the MSRB.

Question 30

Being a Fiduciary

Answer 30

As a result of the Dodd-Frank Act, municipal advisors are considered fiduciaries when their clients are municipal entities. A fiduciary is a person who acts on behalf of another person and this role creates a relationship of trust and confidence. Some examples of fiduciaries include an executor or administrator of an estate, a trustee, a pension plan administrator, and investment advisers

Question 31

municipal advisor

Concept

Answer 31

A municipal advisor is the business or firm, but it’s not an individual employee or owner. A municipal advisor may be organized in a number of ways, including as a limited liability company (LLC), partnership, corporation, or sole proprietorship. A Municipal Advisor Representative is an individual who interacts with clients on the firm’s behalf. However, in the case of a sole proprietorship, the municipal advisor and the Municipal Advisor Representative will be the same person.

Question 32

Municipal Advisor

Defined

Answer 32

A municipal advisor is defined as an individual or entity that:

1. Provides advice to or on behalf of a municipal entity or an obligated person about the issuance of municipal securities or municipal financial products. This includes advising the municipality about the structure, timing, or terms of an issue of municipal securities, but doesn’t include actually underwriting the issue.
2. Solicits municipalities or obligated persons to sell municipal advisory services to them for compensation.

Question 33

Municipal entities

Answer 33

include the states, their political subdivisions, municipal corporate instrumentalities, agencies and authorities, and any other organization that can issue municipal securities. Municipal entities also include investment programs or plans or asset pools that are sponsored by these entities.

Question 34

obligated person

Answer 34

The term obligated person is any person, including an issuer of municipal securities, that’s either generally, or through an enterprise, fund, or account of such person, committed by contract or other arrangement to support payments of all, or part of, the obligations of the municipal securities to be sold in the offering.

Question 35

obligated person

Exemptions

Answer 35

Regarding the rules related the municipal advisors, the following are exempt from the definition:
 A person that provides municipal bond insurance, letters of credit, or other liquidity facilities
 A person whose financial information or operating data is not material to a municipal securities offering, without reference to any municipal bond insurance, letter of credit, liquidity facility, or other credit enhancement
 The federal government

Question 36

guaranteed investment contract (GIC)

Answer 36

guaranteed investment contract (GIC) is a secure investment which helps to preserve the principal of a municipal issuer that doesn’t need all of the funds of a bond issuance right away. In other words, it’s a type of investment for an issuer of municipal securities. The investment earns interest at either a fixed or a variable rate, or based on a predetermined formula. Most GICs offer a guarantee of original investment and interest payments as well as flexible terms of the length of the contract and frequency of interest payments (e.g., monthly or annually).

Question 37

The Advice Standard

and exemptions

Answer 37

According to the SEC, the determination of what constitutes advice is dependent on the particular situation. However, providing general information that’s not tailored to that specific municipality’s needs is not considered advice.
Some examples of general information include:
 Information about professional qualifications and experience
 General market and financial information
 Information about what investments or services are currently offered by the institution
 Factual information which describes the various types of debt financing structures
 Educational materials regarding government programs and incentives
The more tailored the communication is to the municipality’s specific needs, the more likely it is to be considered advice. Anything that rises to the level of a recommendation or a call to action is considered advice.

Question 38

Advice Disclaimers and Disclosures

Answer 38

Some firms may include disclaimers or disclosures in their written material to indicate that they are not making a recommendation or acting as an advisor and therefore don’t have any fiduciary obligations. Although these types of disclaimers obviously argue against a communication being considered a recommendation, they are not controlling. If the overall context in which the communication is made indicates that it’s a recommendation, then the firm may be considered a municipal advisor and possibly be required to register.

Question 39

Responses to RFPs and RFQs

Answer 39

A firm that’s merely responding to a Request for a Proposal (RFP) or Request for Qualifications (RFQ) from a municipal entity or obligated person doesn’t need to register as a municipal advisor. However, if the firm receives compensation (either directly or indirectly) in connection with their response, then they are an advisor and may need to register.

Question 40

Municipal Advisor Registration Exemptions when advice isn’t related to issuance but how to use funds raised etc.

Answer 40

Public Officials and Employees of Municipalities - Normal Duties
Underwriters
Registered Investment Advisers - when advice is not related to issuance
Registered Commodity Trading Advisors (CTAs) - Swap advice only
Accountants attorneys engineers
Banks - Bank product advice only
Municipality Represented by an Independent Registered Municipal Advisor (IRMA) - If the municipality already retained someone other firms don’t need to register.

Question 41

Annual Compliance Meeting

Answer 41

All registered personnel must participate in an annual compliance review. The meeting must include a discussion of compliance issues that are relevant to the business of the registered persons who are involved in the municipal securities business of the dealer.

Question 42

Regulatory Element

Answer 42

A broker-dealer will be notified by a regulator a broker-dealer 30 days in advance of a registered person’s anniversary date. This is the anniversary of the person’s initial registration or a significant disciplinary action. (A significant disciplinary action restarts the clock.) The registered person then has 120 days from that date to complete the Regulatory Element training. If the person doesn’t complete the training within the prescribed time frame, her registration is deemed inactive until she completes the training. A registered person with an inactive registration is prohibited from performing any activity or receiving any compensation that requires securities registration.

Question 43

Firm element

Answer 43

On an annual basis, each municipal securities firm must evaluate and prioritize its training needs. Additionally, a firm must develop a written training plan and conduct annual training. The plan must take into consideration the firm’s size, organizational structure, and the scope of business activities.
At a minimum, the training plan must cover:
 General investment features and associated risk factors
 Suitability and sales practices considerations
 Applicable regulatory requirements
Registered persons who have direct contact with customers as well as the direct supervisors of these individuals are considered covered persons

Question 44

msrb military relief rule

Answer 44

The MSRB applies relief of the examination requirements when a person is either in a special inactive status (serving in the military while still registered), or left the industry and ceased to be registered because he was called for active military duty. If the person doesn’t register within 90 days of the completion of active duty, she must register within two years minus the time between termination and engaging in active service.

Question 45

Continuing Element

Military

Answer 45

The time element that applies to registered persons for continuing education is tolled (taken away) during the period of active military service. Therefore, the requirement to sit for regulatory continuing education based on the second anniversary of initial registration and every three years thereafter is halted and resumes once the individual’s special inactive status ends.

Question 46

Investor and Municipal Advisory Client Education and Protection (G-10)

Answer 46

Once every calendar year, municipal securities firms are required to provide each customer with the following information in either written or electronic form:
 A statement that it’s registered with the SEC and the Municipal Securities Rulemaking Board
 The website address for the Municipal Securities Rulemaking Board, and
 A statement as to the availability of an investor brochure for customers that’s posted on the website of the Municipal Securities Rulemaking Board which describes the protections afforded by MSRB rules as well as how to file a complaint with an appropriate regulatory authority

Question 47

Availability of Board Rules (G-29)

Answer 47

A copy of the MSRB’s rules must be kept in each location in which any of the following activities are conducted:
 Underwriting, trading, or sales of municipal securities
 Financial advisory or consultant services for issuers in connection with the issuance of municipal securities
 Research or investment advice with respect to municipal securities
 Any other activities which involve communication, directly or indirectly, with public investors in municipal securities
The firm must make these rules available for examination by customers promptly on request. The firm can meet these requirements by keeping a hard copy of the MSRB manual at its office or by having Internet or software access to the Board’s rules at its office. (Internet access is available at www.msrb.org.

Question 48

Non-Cash Compensation in Connection With Primary Offerings (G-20)

Answer 48

The term non-cash compensation includes any form of compensation other than cash which is received in connection with the sale and distribution of municipal securities.
Non-cash compensation between the firm and its associated persons is allowed if:
 The non-cash compensation is based on the total production for sales and distribution of specific product types.
 The compensation that’s received is equally weighted for each municipal security within a product type.
 Any person, other than associated persons, is not allowed to participate in the distribution or receive any non-cash compensation.

Question 49

Records Concerning Compliance with Gifts and Gratuities

Answer 49

According to MSRB rules on books and records, a municipal securities dealer must maintain a record of the following information relating to gifts and non-cash compensation:
 A separate record of any gift or gratuity that’s defined under the gift rule (There’s no exception on the dollar value of the gift and it’s a violation if the gift exceeds $100.)
 A record of all agreements relating to compensation for services that are provided to the municipal securities dealer
 A record of certain information relating to all non-cash compensation, such as the name of the person or entity making the gift, the names of the associated persons receiving the payment, the location of the meeting that was used to educate the representatives concerning the securities product, and the value of non-cash compensation received
Firms must maintain records of all gifts given or received, as well as records of compensation agreements and the compensation paid. These records must be kept for six years.